Healthscope investors weigh up risks

Healthscope
’s $170 million to $210 million subordinated retail notes issue marks the return of high-yield bond investment to the Australian market and a chance for the public to invest in a privately owned business.

The 5 1/2-year issue calls on a tried, tested structure championed by bankers at Credit Suisse that has been used to fund private equity transactions for several years.

Emeco, BIS Cleanaway, Affinity Health and Myer have also sold similar subordinated debt structures to take some of their sponsor’s equity off the table and boost the ultimate returns of the buyout. The issues have also offered retail investors a chance to sit alongside private equity investors.

Some analysts have pointed out that if Healthscope does draw on the limited excess debt capacity allowed under the terms of the notes, a fall in the company’s earnings could put the interest rates at risk.

Based on existing covenants agreed with senior lenders, a fall in EBITDA of $35 million could trigger a cessation of interest payments, provided the retail notes raise the maximum of $210 million.

One positive for buyers is that the notes are being issued in an era of more conservatively geared private equity buyouts.

“The nature of these transactions is there is a fair amount of leverage but it is considerably less than what we’ve seen in pre-GFC deals," said FIIG Securities Brad Newcombe.

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Private equity trades originated in 2006 and 2007 typically saw debt levels equal to about 80 per cent of the enterprise value of the target, but the $2.7 billion Healthscope buyout by TPG and Carlyle was only 50 per cent funded by debt.

“The private equity sponsors have $1.5 billion of equity invested so they have skin in the game. It gives a high probability that they’ll look to inject further capital if problems arose. There’s very little incentive to walk away," said Newcombe.

The Healthscope notes will pay a coupon of between 11 and 11.25 per cent, which is higher than the coupons offered for private equity subordinated listed notes sold prior to the global financial crisis.

Based on current five-year bank swap levels, the fixed coupon is equal to a margin of around 5.25 percentage points over the bank bill swap rate.

The health-care sector is one that has made considerable use of the retail bond market. This has created a number of comparable bond issues, albeit across corporate capital structure.

The most obvious comparison are the CARES hybrids, issued by Ramsay Health. These securities had paid a margin of 2.85 per cent over the bank bill rate but recently stepped up to 4.85 per cent when the company chose not to call the securities. This currently equates to a return of about 9.6 per cent.

The CARES notes have no set maturity but the market sees the margin on offer as fair for the risk as the securities now trading close to par value of $100.

Another comparison, identified by analysts, are the senior bonds of Primary Healthcare. In August the company sold $152.3 million of five year senior bonds at a margin of 4 percentage points above the bank bill rate.

Much has been said about Primary’s unsecured retail bonds ranking below its secured bank debt, but the retail notes sit significantly higher in the capital structure than the Ramsay and Healthscope instruments. Also a failure of Primary to pay its retail bond investors would constitute an event of default, whereas both Ramsay and Healthscope could in theory halt payments to their retail debt- holders.

The Primary bonds however have traded slightly wider since issue and are offering a margin of about 4.3 per cent, which based on current rates is the equivalent of about 9.1 per cent. It recently revised its earnings downward but simultaneously cut its dividend from 15¢ to 3¢, in order to conserve cash and appease its creditors.

Given the varying rankings of the listed healthcare notes on offer, there does not appear to be a clear stand-out but the double digit fixed returns are sure to lure investors towards Healthscope’s notes offer.

The best deal however appears to rested with Healthscope’s senior debt providers, who rank highest in the structure have been granted security over the company’s assets, whilst earning a margin of 4.5 per cent above the bank rate.